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December 23, 2019

What’s behind the NordStream2 sanctions

This will be our last newsbriefing for the year. We wish all our readers a happy Christmas, and all the best for 2020. The next scheduled briefing will be on Monday, January 6.

Some of the big developments since our Friday briefing have been that Brexit got finally done, the Bank of England has a new governor, and the US sanctions against the NordStream 2 gas pipeline took effect. 

There really isn’t much more to be said about Brexit - so we won’t. Andrew Bailey is in our view a good and plausible choice for governor of the Bank of England. Our main story story this morning, therefore, is the escalating transatlantic conflict around the NordStream2 gas pipeline. The US' defence budget, which includes the sanctions law, finally passed Congress last week and was signed into law by President Donald Trump. As a result Allseats, the Swiss company that was deploying the gas pipeline in the Baltic Sea, said it was suspending work with immediate effect. 

The Germans were predictably furious, since their whole energy policy depends on a steady supply of Russian gas. This is a geopolitical and environmental nightmare for the rest of the EU. We thought the comments by Richard Grenell, the US ambassador to Berlin, were particularly interesting. He described the decision as a US policy to force a diversification of European energy policy. He called the decision profoundly pro-European, because this was an issue where Germany pitted its own interest against that of the rest of the EU. The Green MEPs Reinhard Bütikofer took up the same line of argument when he mocked the SPD’s defiant response that European energy policy should be decided in Europe and not in the US. This is what Bütikofer wrote:   

"The reality is that the German government has pushed NordStream 2 against the EU, against majorities in the council, the parliament and the commission. This was a German-first policy."

The main beneficiary of a collapse in NordStream2 would be Ukraine, and it is not hard to see why the US administration might be pushing this issue right at this moment given the continued support by President Volodymyr Zelensky for Trump during the latter's impeachment process. 

The sanctions are a small part of the national defence authorisation act, which authorises a $738bn defence budget for 2020. The FT reports that the US senators who sponsored the sanctions part of the bill wrote to Allseas, warning them of crushing and potentially fatal sanctions if they were to continue working on the pipeline for a single day. The purpose of this threat was to warn the company not to use the 30-day cool-off period in the sanctions section of the bill to complete the project, as involved companies initially thought they might be able to do. The letter said explicitly that any attempt to use the 30-day period to complete the project would have devastating consequences for the shareholders of the company. 

The Nordstreat 2 consortium responded by saying that the project will be completed. They are only a couple of months away from completion. Of the 1200km-long pipeline, only 54km are missing. 

The sanctions are unlikely to kill the project. What we now expect is that the companies involved in the project will find someone else to complete the job. We presume this will be a Russian company that is immune to additional US sanctions. We expect that this dispute will ultimately be folded into a broader list of US sanctions and tariffs against European companies. We expect this to become one of our main themes in 2020.

Germany had hoped to counteract one of the arguments against NordStream2 by brokering a gas-transit agreement between Russia and Ukraine last week. The deal is for an initial period of five years, with an renewal option for another 10 years. 

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December 23, 2019

An important ruling by the Dutch constitutional court

The politics of climate change has been intruding into our sphere in a number of ways, ranging from the debate on green QE to the possible exemption of climate-related investments from the eurozone's stability rules. Another important aspect for us is the impact that differential progress on national climate change targets may have the EU’s internal cohesion. As we keep writing, Angela Merkel’s administration has no intention to fulfil Germany's Paris targets, just as it has no intention to fulfil the Nato defence-spending goals. But, on climate, the Netherlands and France are moving in the opposite direction to Germany. And therein lies the potential for conflict.

The Dutch constitutional court ruled on Friday that the Dutch government has to fulfil its climate change targets strictly. The concrete consequences of the ruling will be that the Rutte administration will need to step up efforts from next year to reduce CO2 emissions to 25%, relative to 1990. So far the government was trying to hide behind the EU average of 20%. The legal basis for the ruling is not EU law, but the Council of Europe's European convention on human rights. The court has ruled that the current government policies constitute a human rights violation.

It will be interesting to watch whether this ruling will open up a new legal avenue for climate change activists in other member states. We doubt they will succeed in Germany, given the German constitutional court’s top-dog mindset. The result will be a policy discrepancy between major eurozone member states in one of the most important policy areas of the next decade.

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December 23, 2019

This time Popolare di Bari brings EU bank resolution into question

As the year draws to a close, the rescue of Banca Popolare di Bari promises to become one of the major political controversies of the new year.

Popolare di Bari is one of the last Italian cooperative banks whose conversion to a listed company was pending following a law approved in 2015. But the transformation requires floating the company in the stock market, and that can bring up balance sheet problems. Popolare di Bari decided earlier this month that it needed a capital injection of about €1bn. Within about a week, however, the Bank of Italy in its capacity as banking supervisor decided to put the cooperative bank under special administration. This mimics the decision made by the European bank supervisor, the single supervisory mechanism of the ECB, to put Banca Carige under special administration in the first week of this year. 2019 thus ends like it began, with a mid-sized Italian bank being put under administration by the supervisors.

Carige still took about six months to go through various options for a restructuring and capital raise, but it looks like things are proceeding faster in the case of Popolare di Bari. And they are doing so on the basis of recent decisions by European authorities on other banking rescues, in Italy and abroad. 

The Italian government approved a €900m recapitalisation of Banca del Mezzogiourno - Mediocredito Centrale, a state-owned investment bank focused on the South of Italy where Popolare di Bari is most active. Of these funds, Mediocredito Centrale will use €500m to recapitalise Popolare di Bari. The Italian government is confident that this recapitalisation of a publicly-owned bank will receive the assent of the European Commission's competition authorities. After all, just this month the European Commission allowed the state governments of Lower Saxony and Saxony-Anhalt to recapitalise NordLB, a bank they already own following a rescue earlier in this decade.

The remaining €500m will probably come from Fitd, the Italian deposit guarantee fund. One precedent for this is the involvement of the so-called voluntary scheme of the Fitd in the rescue of Banca Carige over the past year and a bit. But also the main compartment of the Fitd may now get involved as this past March the ECJ ruled that use of deposit guarantee funds for a capital plan is not necessarily state aid. Coincidentally, the ECJ decision pertained to use of Fitd funds to ease the acquisition by Popolare di Bari of banca Tercas, another bank that was failing in 2013. The European Commission objected to that operation as illegal state aid, which delayed the takeover and prompted the creation of the purely-private Fitd voluntary scheme. So, with the Fitd now likely to become involved in the rescue of Popolare di Bari itself, the story comes full circle.

The takeover of Banca Tercas by Popolare di Bari is now being blamed for worsening Popolare di Bari's asset quality and ultimately leading to the capital needs that have precipitated it being put into administration. So, politicians across the political spectrum, from government supporters such as Luigi di Maio or Matteo Renzi to opposition leaders such as Matteo Salvini, are also blaming the Bank of Italy. The central bank stands variously accused of looking the other way, or being too slow to act. 

But when Italian politicians are not blaming the central bank for failing to avoid bank bailouts, they are normally critical of the push to force Italian banks to offload their nonperforming loans. So, we would not pay attention to politicians' attempts at point-scoring, or the excuses put up by the central bank. We should take a step back and look at the bigger picture, and realise that not only in Italy but also in Germany and in other countries EU bank resolution rules never seem to work as intended. Ultimately, ways are found to prevent fallout from failing banks. And lately shareholders and subordinated bondholders are losing their investment, even if there is no bail-in of senior bondholders under the EU's bank resolution rules. In the case of Popolare di Bari, the existing cooperative members will probably lose the entirety of the value of their participations in the bank.

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December 23, 2019

The reversal of the eurozone external balances

We end the year by noting the continuing shrinkage of the eurozone's current account surplus, and the reversal of the direction of foreign direct investment. These are trends we have been following for over a year now, and which show no sign of abating. They are directly related to the weakness of eurozone GDP, as net exports have been making a negative contribution to economic growth even though gross exports have continued to rise albeit more slowly than imports. If one believes, as we do, that the recession in the manufacturing sector, particularly in Germany, is a sign of a long-term structural change, then the reversal of the balance-of-payments trends of the past decade is also significant. The eurozone's strategy to get out of the government debt crisis at the start of the current decade was for all countries to attempt to run current account surpluses. This was always unsustainable and is patently not being sustained. As the eurozone has not instituted any other compensatory mechanisms, there may be trouble ahead as some countries turn back to running current account deficits.

In the twelve months to October, the running-twelve-month eurozone's current account surplus estimated by the ECB was €324bn or 2.7% of GDP, significantly lower than a year earlier when it was €373bn or 3.2% of eurozone GDP. We recall the twelve-month running current account surplus peaked in the middle of 2018 above €400bn or 3.6% of GDP. The declining trend seems robust and there is no indication that structural factors will reverse it.

As to the composition of the financial account, the counterpart of the current account, we have noted in the past the reversal of foreign direct investment flows, both on the asset and liability side. This became visible in the data about a year ago, and the trend has grown stronger with time, too.

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December 23, 2019

No Christmas truce in France

The saga of strikes against pension reforms continues, promissing travel chaos in France for many who want to join family and friends over the Christmas holidays. The second largest union Unsa was the first to decide for a Christmas truce, but this will not be followed by all its grassroots. The CFDT union, relatively small in transport but big in the public sector, turned down the deal offered by the government and is calling for further mobilisation in January instead. The strike actions in transport are concentrated in the Paris area at the moment, with only half of the trains and two metro lines running.

The decisive question now is: will the public turn against strikers or against the government, amid the stories of stranded travellers in the Christmas period? The latest poll in Le Figaro suggests that support for the strikers has been falling from 54% to 51%. But those affected by the travel chaos in are expecting the government to do something about it in the coming days.

Emmanuel Macron called on the spirit of responsibility, and for a truce to respect families. The government seems confident that the public has taken on board the two basic principles of the pension reform, a point system and the end of special pensions, and that the rest is up to negotiations due to start again in January. But unionists do not want to lose protest momentum. For many of them the next big strike day on January 9 is too long to wait for. Strike actions continue in transport for the next two days and many trains and metros will not be running.

The government and unionists both will have to tread carefully not to lose hold of their narratives in the coming days. Macron's move over the weekend to give up his own pension is a PR stunt that could go either way. The left and unionists already denounced it as pure propaganda. But unionists also cannot take public support for granted. The SNCF had to reinstate a service to accompany children on trains that they had meant to cancel due to strike actions, after an outcry from families across the country.

The unions dream to repeat the success of the strikes in 1995, when after three weeks of action the Juppé government withdrew its pension reform. Macron and Édouard Philippe insist that this time it is different. Playing for time by promising more carrots for trade unions in January and calling for a Christmas truce is their best bet to pass responsibility for the ensuing chaos to the the unions. These risk losing public backing and momentum over Christmas. But the government's bet is not won yet. Small announcements can have big effects. Macron will have to resist his own impatience and his drive for more PR stunts, and the government as well as the majority will have to keep it together. The question is who will blink first in this multi-layered strategic game. 

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December 23, 2019

Brace for Erdogan's foreign policy ambitions

Recep Tayyip Erdogan is a man to watch out for in 2020. Weakened at home, he is seeking refuge in foreign policy where he is trying to carve out a pivotal role for Turkey in the Eastern Mediterranean region. He is shaking up relations with Turkey's neighbours, so far concentrating efforts on Libya and Syria. Turkey is also likely to start exploring and drilling for gas using the sea border agreed with Libya. Erdogan' promise to support the Libyan government against a military offensive by general Khalifa Haftar has irritated Egypt and the UAE, as both support Haftar. The oil and gas reserves in the Eastern Mediterranean are likely to stir up further tensions in the region.

Turkey is also on the line over its military offensive in Syria, after the US left the region and the Kurds behind. Erdogan is looking to settle more Syrian refugees on the 35km corridor Turkey patrols together with Russia. At the same time Erdogan is warning that Turkey is unable to receive a huge wave of Syrian refugees fleeing the last rebel-held province of Idlib after advances from the Russian-backed Syrian army. Up to 3m people live in this province. Erdogan promised yesterday that this new influx of refugees would be felt in Europe.

The EU, Greece and Cyprus in particular will have to prepare for an escalation while keeping diplomatic channels open. United in their opposition to Turkish pressure, the leaders of Cyprus, Greece and Israel plan to sign an agreement early in the new year for the building of an eastern-Mediterranean natural-gas pipeline. Greece, backed by the EU and Emmanuel Macron at least in words, is also preparing for Turkey to enter its waters. Erdogan is spreading himself thin with simultaneous high-risk plays on various fronts. The Europeans will have to keep their nerve while protecting their interests.

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December 23, 2019

On the decline of the centrist left

One of the main themes at Eurointelligence in this outgoing decade has been the largely self-inflicted decline of political centrism in the eurozone. It was the charge of the centrist light brigade into austerity and supply-side economics that effectively killed the soft centre-left in several EU countries: France, Germany and Italy. In the UK, Blairism was exorcised some time ago and, no matter what now happens in the Labour Party, that particular flavour of social democracy won’t return.

Wolfgang Münchau writes in the Financial Times that the decline of the centre gave rise to populism in some countries, but not everywhere. In Germany, the decline of CDU and SPD strengthened both the Greens and the AfD. In France, the decline of the previous centrist parties gave rise to a new radical centre. In the UK, the voting system ensured that the two centrist parties remained formally in place, but they became radicalised internally. Italy is where the decline of the centre-right and the centre-left has given rise to strong populist parties. But one of them, Five Star, is already in decline. 

We noted an interesting comment in FAZ over the weekend by Werner Mussler, the paper’s Brussels correspondent. He adds some additional anecdotal evidence to our theme. He makes the point that Olaf Scholz’s eurozone policies are utterly confusing and self-defeating. Mussler does not talk about the merits, or otherwise, of further eurozone integration. His point is about consistency. Virtually all the eurozone-related projects Scholz has touched in the last year have ended in failure. This is very much in line with our observation that the political centre is useless at solving the problems that their past policies have created. 

Mussler notes that Scholz and Bruno Le Maire were given the task to draw up a blueprint for a eurozone budget partially funded by a financial transactions tax. The ESM was supposed to turn into an IMF, and act as a backstop for the single resolution fund. Scholz' final project was to complete the banking union.

The Franco-German proposal for the eurozone budget has gone nowhere. The Italians are blocking ESM reform. And they are not even prepared to discuss Scholz’ proposals for banking union, just as we predicted. Mussler is particularly critical of Scholz’ misleading comments on the financial transaction tax. There is currently no majority among the group of countries that is debating the issue. It appears that Scholz is positioning himself on the left of his party only to be able to blame others if, or rather when, the project fails. We agree with Mussler’s conclusion: Scholz has lost his political orientation, and is overwhelmed. This is not sustainable. Something will have to give in 2020.

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